Shareholders Must Vote To Rein In Executive Pay

KATHY KRISTOF COLUMNIST

June 15, 2004|KATHY KRISTOF COLUMNIST

Shareholders, read your proxy statements. And vote.

Every spring, stockholders in thousands of public companies receive annual reports and proxy statements that show how their companies performed and how that performance translated into pay for the corporation's top officers. The proxy statements also ask investors to elect company directors and vote on other matters of importance.

Executive pay is dominating the discussions among institutional shareholders this spring, as labor strife and accounting scandals continue to land in the news. To understand why, a brief financial history is required.

This year, the median pay for chief executives topped $10 million, experts said. That's more than 300 times the pay of the average manufacturing worker, according to the Boston-based group United for a Fair Economy.

It wasn't always so. CEOs used to earn about 40 times the pay of manufacturing workers, said UFE's Scott Klinger. But in the past dozen years, a trend toward "pay for performance" has caused executive paychecks to soar. The theory was this: Executives would be encouraged to think more like shareholders if they were given economic rewards, such as stock options, that would pay off when the company prospered.

The experiment has been hugely lucrative for executives, but it has been a disaster for shareholders -- and sometimes for employees. Not only are shareholders paying more for often dubious performance compensation, but experts maintain that some companies set increasingly easy performance criteria to ensure that executives always hit their performance targets. One UFE study found that executives at companies that had laid off workers got the biggest raises.

"What we have is not only huge pay, it's pay that is insensitive to performance," said Graef Crystal, a San Diego compensation specialist who sheepishly admits that he structured one of the nation's first pay-for-performance packages.

Yet year after year, in study after study, Crystal has only been able to find one direct link between performance and pay. It happens when companies provide unusually large grants of stock options, he said. More bad news: The correlation is negative. Crystal said that over a five-year period, companies providing mega-grants of stock options are highly likely to underperform when compared with their peers.

Crystal now thinks that the problem with pay for performance is that it was directed at the wrong employees.

"Money motivates somebody working at Wal-Mart trying to feed his family," Crystal said. "But these executives are already throwing off cash that they don't know how to spend. No one has ever accused CEOs of sloth. These guys are not saying to the board, `If you don't give me more money, I won't give you my best thinking.' It's just crazy. We just extrapolated to the wrong group."

So what are shareholders getting for the upward march in executive pay? Corporate scandals, labor strife and shareholder dilution, some experts contend.

"The problem with executive compensation is that business ethics are not applied to it," said Paul Hodgson, research associate at The Corporate Library, a corporate governance Web site. "If you stand back from the series of corporate scandals that we have seen and ask why they occurred, compensation lies behind almost every one of them. It's greed for power, I think -- money being the most obvious badge of power."

It's extremely difficult for employees to accept cost-cutting decisions -- whether they're decisions to outsource workers, or to cut the wages or benefits of rank-and-file employees -- when the top executives are taking home multimillion-dollar bonuses, Charles Peck, a compensation specialist with the Conference Board in Washington, D.C. said.

"Executive compensation always stands out because you have one person earning so much money," Peck said. "When you look at it in dollar-and-cents terms, it's nothing. But there are psychological and perceptual ramifications. The possibility exists that you're setting yourself up for labor strife."

Big institutional shareholders also complain that the vast numbers of stock options provided to executives are diluting the interests of existing shareholders. This is one of the reasons that pay now accounts for about one-third of all shareholder-sponsored proxy initiatives, said Brian Heil, founder and chief executive of ProxyMatters.com.

Investors who think runaway executive pay is hurting investment returns, or creating moral or morale issues, have only one way to fight back, Heil added. "Voting the proxy is the only voice that a shareholder has," he said.